Press Information Bureau Government of IndiaMinistry of Finance26-February-2016 12:17 IST

The Chakravyuha Challenge: Ease to enter, barriers to exit

Indian Economy making great strides in removing barriers to entry for firms, talent, and technology but less in relation to exit

The Economic Survey 2015-16 presented here today in the
Parliament by the Union Finance Minister Shri Arun Jaitley invokes the legend
of the Charkravyuha from the Mahabharata describing the ability to enter but
not exit, with seriously adverse consequences. The Indian economy has made
great strides in removing barriers to entry for firms, talent, and technology
but less progress has been made in relation to exit. Thus, over the course of
six decades, the Indian economy has moved from ‘socialism with limited entry to
“marketism” without exit’.

The Economic Survey 2015-16
states that the case studies suggest that the challenge is more a feature
of the relatively traditional sectors of the economy. It is not restricted to
the public sector but is increasingly being seen in the private sector. India seems
to have a disproportionately large share of inefficient firms with very low
productivity and with little exit. This lack of exit generates
externalities that hurt the economy.

Impeded exit has substantial fiscal,
economic, and political costs.

·Fiscal
Costs: Inefficient firms often require government support
in the form of explicit subsidies (for example bailouts) or implicit subsidies
(tariffs, loans from state banks).

·Economic
Costs: Misallocation of scarce resources and factors of production
in unproductive uses including overhang of stressed assets on corporate and
bank balance sheets.

·Political
costs: Government support to “sick” firms can give the
impression that government favors large corporates, which politically limits
its ability to undertake measures that will benefit the economy but might be
seen as further benefitting businesses.

The Economic Survey analyses this exit
problem with the help of the three I’s:

·Interests:
The
power of vested interests confers greater power on concentrated producer
interests in relation to diffused consumer interests. As a result it becomes
difficult to phase out schemes and they become instruments of granting favors.
For example, 50 percent of Central Sector Schemes that were allocated money in
the Union Budget 2015-16 were 25 years old. Thus, extra vigilance is required
to ensure that schemes remain relevant and useful over time.

·Institutions:
Weak
institutions increase the time and financial costs of exit. For example, with
rising non-performing assets, recourse to debt recovery tribunals (DRTs) has
increased. The share of settled cases is becoming small and declining and the
accumulated backlog of unsettled cases has increased manifold. Furthermore,
inability to punish wilful defaulters questions the legitimacy of all
institutions.

On the other hand, strong but
inflexible institutions are unable to make risky decisions when departures from
strict principles may be necessary for the economy.

·Ideas/Ideology:
The founding ideology of state-led development and socialism makes it difficult
to phase out entitlements even as those intended for the poor end up accruing
to the relatively better off.

The Economic Survey 2015-16 suggests
five possible ways to address this problem. The first is promoting competition
via private sector entry rather than change of ownership from public to
private. Secondly, direct policy action through better laws like the Insolvency
and Bankruptcy Code 2015 will expedite exit. Also institutions need to be made
stronger but flexible by empowering bureaucrats and reducing their
vulnerability. Thirdly, increase the use of technology to remove persistent
distortions by bringing down human discretion and layers of intermediaries. The
fourth is increasing transparency and highlighting social costs and benefits of
various schemes and entitlements. Finally, showcasing exit as an opportunity
towards a newer and better tomorrow.